The buyer wants a ten percent cash indemnity escrow held for eighteen months to cover potential breaches of representations and warranties. When does it make financial sense to purchase a Reps and Warranties Insurance policy instead to release that cash at closing?

Question

Tyler Smith · Accepted Answer

In lower-middle-market transactions, buyers routinely demand an indemnity escrow between eight and twelve percent of the enterprise value, held in a third-party bank account for twelve to twenty-four months. This capital sits idle to cover potential post-close breaches of representations and warranties. For a twenty-million-dollar deal, that means leaving two million dollars of your proceeds at risk.

Reps and Warranties Insurance (RWI) allows you to replace this seller indemnity escrow with a third-party insurance policy. Under an RWI structure, the buyer recovers losses directly from the insurer, reducing your closing escrow down to a minimal retention pool, often less than one percent of enterprise value.

Deciding whether to use RWI comes down to deal scale and transaction economics:
- Enterprise value threshold. Historically restricted to mega-deals, RWI is now common in transactions between fifteen and thirty million dollars. Mini-RWI products exist for deals down to ten million dollars, though minimum underwriting fees make them less efficient below that level.
- Premium and underwriting costs. An RWI policy typically carries a one-time premium between two and three percent of the total policy coverage limit, plus an underwriting fee of twenty to forty thousand dollars. In a competitive sale process, you can negotiate for the buyer to split or absorb these costs as part of the transaction expenses.
- Elimination of clawback risk. Standard escrows invite buyers to fabricate post-close warranty claims to chip away at your deferred cash. With RWI, claims are adjudicated by an independent underwriter, allowing you to walk away from the closing table with ninety-nine percent of your net cash proceeds fully realized.

If your enterprise value exceeds fifteen million dollars, mandate an RWI policy inside the Letter of Intent to secure clean cash at close.